As your entrepreneurial venture grows and you find yourself needing to hire employees to help take on the increasing workload, you need to learn how to do payroll for a small business. First, you need to decide what your payroll strategy will be.
You can learn how to do payroll yourself or hire an HR manager to take care of it in-house each pay period. But you can also outsource the tedious task through either an accountant or online payroll software.
If you do not want to pay the fees that come with the help of an accountant or online payroll service, learning how to do payroll yourself might be your preferred method. Processing your small business payroll on your own does come with its own set of challenges.
However, as long as you have the right checklist, enough time, and a little bit of patience, there’s no reason you can’t do it manually.
Before you hire an employee
Before you bring on any full- or part-time employees to help you with your business, there are a few steps you need to take to get started processing payroll.
Get an Employer Identification Number (EIN)
In order for the IRS to track your business’s payroll tax forms and payments, they require you to obtain a Federal Employer Identification Number (EIN or FEIN). You can apply for one for free on the IRS website.
Note: You will also need to register with your state as an employer, but the steps are different for each state. Visit your state’s Department of Revenue and Department of Labor to learn more about what you need to do.
Register with the Electronic Federal Tax Payment System (EFTPS)
If you’re giving employees paychecks and running payroll, you’re required to pay taxes. You can do so online by registering with the Electronic Federal Tax Payment System (EFTPS), a free online tool you can use to pay your federal payroll taxes and federal unemployment taxes.
You can sign up for your EFTPS account here.
Learn the laws on how to do payroll for small business
Probably the most tedious aspect of learning how to do payroll for a small business is making sure you are up to date on every law you must follow in terms of paying employees. Here are a few laws you absolutely need to know before your first pay period:
- Your local minimum wage
- Overtime laws
- Payday requirements
- Final paycheck laws
- Withholding requirements
- State disability insurance requirements
- Local income tax requirements
- Required breaks
- Workers’ compensation insurance requirements
- Additional tax withholding requirements by state
Determine your payroll schedule
After you learn your state laws on how often you need to pay your employees, you can set a payroll schedule for your team that keeps you compliant and works for your business. A payroll schedule consists of a pay period (how long people work) and a pay date (when people get paid).
After you hire an employee
Collect new hire paperwork
Your employees need to complete new hire paperwork after they accept a job offer. The required forms give you the information you need to run payroll, including employment eligibility, tax withholding, and direct deposit information.
Learn more about the required paperwork in our article on the necessary new hire forms you need for each employee.
Tip: Homebase hiring and onboarding will send a packet to each of your new hires with all the required forms they need to complete. They can even fill out the paperwork online and have it ready to go before their first day.
Report new hires to your state
Before running payroll, you need to submit your new employees to your state’s new hire reporting agency, which you can find here. However, if you outsource your payroll process to a service like Homebase Payroll, your provider will typically complete this step for you.
What you need to get started
Before you start running payroll manually, make sure you have the following things ready:
- Your employees’ Forms W-4 to determine how much you’ll withhold in taxes.
- The federal payroll tax withholding rates, which you can find here.
- Any state and local tax withholding rates you are subject to.
- Your state unemployment tax rate.
Calculating gross pay
Your employees’ gross pay is the total amount of money your employee earns each pay period before payroll tax withholdings, retirement contributions, and health benefits are deducted.
If you employ hourly workers, multiply the employee’s hours worked by their hourly wage.
Here’s an example: If the employee’s hourly rate is $10 an hour, and they worked 40 hours for the weekly pay period, then their gross pay would be $400.
If you employ salaried workers, divide the salary by however many pay periods are in your payroll schedule for the year.
Here’s an example: If your employee’s salary is $50,000, and you run payroll 24 times each year, then their gross pay for each pay period would be $2,083.
If your employee receives any of the following during each pay period, you’ll have to add them in as well:
- Overtime pay
- Sick and vacation pay
Calculating pre-tax deductions
A pre-tax deduction is a deduction from an employee’s gross wages. Common pre-tax deductions include health benefits, retirement contributions, or disability insurance. Before payroll taxes are calculated, you’ll need to subtract these deductions from the gross wages.
For example, if an employee contributes $100 per pay period to their health insurance premium, you would deduct $100 from their gross pay.
Calculating federal tax withholdings
After pre-tax deductions are made, you have the employee’s taxable gross pay. Now you have to withhold employee payroll taxes mandated by the federal government. These include:
Your employee’s FICA payroll taxes are their contribution to Social Security and Medicare. The Social Security tax rate for an employee is 6.2%, and the Medicare tax rate is 1.45%.
Federal income tax
If your employee’s gross pay equals less than $100,000 per year, you will use the wage bracket method to calculate federal income tax withholding. You will use the IRS income tax withholding tables to find your employee’s wage range.
If your employee earns more than $100,000 per year, you need to use the percentage method, which is a bit more complicated. You can learn more about this method as well in the link mentioned above.
Your state may require you to withhold more in taxes from your team’s paychecks. Be sure to check with your state’s department of revenue website to learn more.
Subtract other mandatory or voluntary deductions
You may need to withhold other taxes from your employee’s paycheck, including voluntary deductions like union dues or mandatory wage garnishments that might be deducted to cover things like unpaid child support or delinquent student loans.
If your employee has a wage garnishment requirement, the government will let you know how much you need to withhold and where to send the wages.
Disperse paychecks and maintain records
Once all aspects of payroll are calculated, you need to pay your employees. Most states require you to provide a pay stub, so make sure to include one that includes all the requirements your state mandates.
Next, record the payroll totals for all employees so that when you are submitting payroll taxes and quarterly and annual reports, you’ll have the information ready to go.
Keep a record of the following for each employee:
- Gross pay
- Voluntary deductions
- FICA payroll taxes
- Federal, state, and local withholdings
- Wage garnishment totals
Calculating federal employer taxes
You are responsible for FICA payroll taxes, which are the same as an employee’s rates (Social Security 6.2% and Medicare 1.45%).
Also, you’re responsible for FUTA payroll taxes, which contributes to federal unemployment insurance. You are responsible to pay 6% of each employee’s first $7,000 in wages. Once your employee earns that $7,000, you are no longer responsible for FUTA taxes.
State employer taxes
You are required to pay State Unemployment Insurance Taxes, no matter which state you operate in. Each state tax rate varies, and you will receive the rate when you register as an employer with the state department of labor. Your rate can change year-to-year, and the state will inform you of any changes.
Paying payroll taxes
Your tax deposit schedule depends on what type of schedule you have, which is based on your payroll tax liability for the previous quarter, or the 12-month period that ends on June 30, which is called a “look-back” period.
Take a look at the IRS’s guidelines on deposit schedules to determine which one you need to follow.
If you owe more than $500 in FUTA taxes, you need to pay them on the last day of the month at the end of each quarter. However, if you owe less than $500 in a quarter, you don’t need to make a deposit—the amount will roll over to the next quarter and you’ll owe a deposit once the total is at least $500.
If you never reach $500, the total amount you owe is due by January 31 of the following year.
Quarterly and annual tax forms
You are responsible for filing Form 941, Employer’s Quarterly Federal Tax Return, every quarter. From this form the IRS learns how much money was withheld from each employee’s paycheck, as well as how much you paid in employer taxes for the quarter.
You must submit this by the last day of the month after the end of every quarter; you can do so online here.
You must file Form 940, Employers’ Annual FUTA Tax Return, if you:
- paid at least $1,500 during the year in wages for your team
- employed someone for at least 20 weeks during 1 year.
This form is due January 31, but if your FUTA payments were on time, you have until February 10. You can also submit this form online here.
The Form W-2 needs to be completed for every employee every year. The form is used to report yearly wages for your team, as well as deductions and tax withholdings. You will need to send a copy to each employee, the Social Security Agency, and your local tax department by January 31 annually.
You can purchase the forms from your local office supply store and prepare and file them yourself, or you can use an online service that files the forms for you electronically and sends copies to your team.
How to do payroll for a small business with some help
As you can see, there are a lot of steps involved in learning how to do payroll yourself. So it might make sense for you to utilize the help that is available to you in the form of online software or accountants.
Hiring an accountant might be an option for you if you want to be entirely hands-off throughout the payroll process. Your accountant would handle all aspects of payroll for you. However, be prepared to pay more in fees than you would if you instead used online software.
Online payroll software
Online payroll solutions handle all of the payroll heavy lifting by doing calculations, tax filings, and quarterly and annual reports for you.
If you use an online system your only responsibility is to enter hours worked for each employee. However, if you use Homebase, your timesheets turn into hours and wages in payroll automatically, so your only job is to approve the payroll. Get started with Homebase Payroll today to learn more about how easy running payroll can be each pay period.